An Exclusive Look Inside A Weed-Delivery Startup With Billion-Dollar Dreams

Ron Strider

Well-Known Member
Cannabis delivery startup Eaze Solutions Inc. has a lofty goal: By fiscal year 2020, it expects to ship the rough equivalent of a 33-foot-cube of marijuana – nearly three joints for every registered voter in the U. S. – to weed fans in America's legal markets.

The goal of moving the equivalent of $1 billion in cannabis and related products in a year has led the company to burn about $1 million a month as it aggressively expands into markets that have, in some cases, proved costly, according to information provided to potential investors and exclusively obtained by MarketWatch. The documents render a snapshot of a company wrestling with complex, often difficult regulations, that's pushing the boundaries of what's legal in a market where the laws are changing rapidly and causing uncertainty about the potential for investments.

When contacted about this story, Eaze Chief Marketing Officer Stephen Matt wrote in an emailed statement, "While we don't disclose revenue or discuss future plans, the marijuana industry is incredibly promising, and presents an opportunity that innovators, investors and policy makers alike are excited about."

Born in 2014, Eaze's origin sounds similar to startup success stories such as Airbnb and Uber, and like those two it also claims to only produce tech that connects people, rather than selling pot itself. Founder and former chief executive Keith McCarty used his own money to launch the company from his San Francisco apartment with four employees and the idea of promising delivery of medical marijuana within minutes. McCarty, an ex-Yammer employee who received a healthy payout when Microsoft Corp. MSFT, -0.08% acquired the company for $1.2 billion in 2012, even helped fulfill early orders, packing driver kits in his apartment.

Since its humble beginnings, Eaze has developed an expansive delivery footprint in California that has given it a dominant position and attracted outside investment. It has banked $24.5 million in venture funding from investors including rapper and entrepreneur Snoop Dogg's Casa Verde Capital LLC, as well as a number of well-known Silicon Valley venture-capital firms. It now seeks an additional $25 million in funding, according to the investor deck.

Heralded by the tech trade press as the Uber of pot, Eaze has expanded alongside the legal market, which has reached $6 billion in annual sales across the country, according to a report from Cowen and Co. Marijuana continues to be classified by the federal government as a Schedule I drug, along with heroin, LSD and ecstasy. As a result, federal law requires banks to report any marijuana-related transactions as suspicious activity, which could open them up to seizure by the Federal Deposit Insurance Corporation. .

Despite federal prohibitions, Eaze now operates in more than 100 cities as executives leverage generous promotions, fierce expansion and, per several sources, hardhearted negotiation tactics. It also launched a line of vaporizers, is planning to create private-label cannabis brands, and offers low-cost marijuana recommendations under EazeMD.

Yet on-demand pot delivery has not blossomed to the same extent as the total marijuana market. The practice is banned outright in some states where recreational pot sales are legal, such as Colorado and Washington. Where it is legal, such as in Eaze's home state of California, delivery is something of a work in progress, with regulations resembling a motley patchwork ranging from pot-friendly to effective prohibition.

Eaze claims in its pitch deck to potential investors that it will expand to one of the markets on the more negative side of that scale this year: Los Angeles, a city that has banned delivery outright. Los Angeles officials did not sit idly by as other delivery companies attempted to make bank on clandestine sales, squashing or muscling out several upstarts, and the pitch to investors did not give insight into how Eaze will avoid the same treatment.

But Eaze's forays into other areas in Southern California show that regulatory roadblocks may not be the only issue that keeps Eaze from succeeding.

The massive costs of 20-minute delivery

The promise of marijuana delivered within 20 minutes, while attractive to customers, has pushed per-delivery costs in Orange County to top out at $27, MarketWatch has learned. Delivery costs matter to Eaze. It does not charge for delivery but rather takes a cut from each sale that it looks to recognize in its financials as a technology fee, so large delivery fees on small purchases of pot can add up to big losses.

"In some of these markets, it can be prohibitively expensive to be sending drivers out to only be doing one or two transactions in an hour," said Morgan Pahxia, managing director at Poseidon Asset Management LLC, an asset-management company that focuses exclusively on the marijuana industry. "That's just crazy. You have to be at such high velocity."

Orange County is something of an outlier, as per-market delivery costs can drop to as low as $6 in tightly-packed urban areas such as San Francisco – the second densest city in the U. S. – and the midrange for many markets Eaze operates sits between $8 and $12 per delivery, averaging about $9 to $10 across all its markets in the Golden State.

Khaled Naim, CEO of Onfleet, a company that makes delivery-logistics software, says costs in the $6 to $12 range are not outrageous, likening pot to the economics of alcohol and pharmaceuticals delivery, both of which can be profitable with those delivery costs. "With a 30% margin, you can easily do a couple of deliveries in an hour in a big enough market with a good enough product."

Yet Eaze's cost of revenue and operations dig deeply into its bottom line. According to the pitch deck, the company expects a $12 million loss before interest and taxes in fiscal year 2017, widening from $8 million in 2016. The costs, broadly, are broken into two segments: cost of revenue, which will grow to $16.8 million this fiscal year compared with $7.1 million in 2016, and operating expenses, which it expects to widen to $14 million from $9.5 million in 2016.

While not as unmanageable as the Orange County costs, the money Eaze must spend to deliver marijuana in other cities will still make turning a profit difficult without immense expansion.

"Delivery is a tough business, ask anyone even in mainstream industries. You have to be a large company, which can only be done at scale – which Eaze is trying to do," said Ben Larson, co-founder of Gateway Incubator, a marijuana startup accelerator. "But this isn't pizza delivery...[regulations] are going to drive up the cost of delivery. It's going to be very slim margins, and so what I think it's going to do is to drive the company to add other revenue models."

'It still kind of feels like a drug deal'

To some extent, Eaze looks to be moving toward alternative revenue streams. Its vaporizer cartridge line is one example, reaching $1 million in sales within four months of launch, according to the investor deck. It's less clear what the potential returns for its coming private-label brand will be, but the deck says that it can "fill gaps in the market" and that because there are no marketing or distribution costs, Eaze will receive a higher retail margin and can scale quickly.

What's clear from the investor materials is that Eaze's revenue has been climbing steadily: Executives forecast a 112% rise to $18 million in fiscal year 2017, from $8.5 million in 2016. Between 2015 and 2016, revenue rose 118%.

Eaze's expanding losses despite the revenue gains may be one of the reasons the company's founding CEO, McCarty, ceded the top boss job to another ex-Yammer employee, Jim Patterson, in 2016. It also may be why the company is seeking new funding, as well as its expansion plans for Los Angeles and the rest of the state as California prepares for recreational legalization to take effect in 2018.

But for pot businesses, regardless of the fact that Eaze says it's a tech company, raising more cash is not a by-the-numbers operation as with other entirely legal startups.

"One thing different for this industry, is that it's very undercapitalized," said Pahxia. "There's no guarantee the next round of funding is there."

Even if it can get enough funding and avoid regulatory challenges to keep growing, Eaze will still have to overcome the economics of the industry to become profitable, investors say. As the industry matures and products and services become more alike, says Larson, the economics around marijuana farmers and retail operations, including Eaze, will tighten.

"As the industry grows and becomes more efficient and things become commoditized, [pot growers and retail] will be the two endpoints that get pinched the most," said Larson. "Dispensaries and grows are historically not just very scalable businesses, and if they are it's at very low margins. And I think that's where Eaze will find themselves, especially if they haven't built a strong brand."

If Eaze is able to build a profitable business out of delivering marijuana, it could be in danger of larger, more established businesses butting in to the industry. At least in the near term, Eaze likely will not have to fight with existing delivery businesses such as GrubHub Inc., or United Parcel Service Inc., said Onfleet CEO Naim.

"Even if it is recreationally legal on the state level, a company like Amazon will never touch it," he said. "Even if it is federally legal, it's still a controversial thing. If you have big enough business elsewhere, [cannabis] might tarnish it, especially if it might anger a big part of their investor base. Wal-Mart won't do even do cannabis delivery because it's a brand risk."

But that doesn't mean states such as California and beyond cannot support more than one significant company in the market, Larson says.

"We feel that there is room for a competitor that builds their company around a strong brand, and a vision that resonates with the millennial market, and finding the brand that people will shop at," Larson said. "But people drive toward convenience in cannabis. I've done Eaze orders here and there, and it still kind of feels like a drug deal."


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